The steady fiscal gains state governments have made since 2000, and expect to make going ahead, are under threat. A new study by CRISIL reveals that the constitution of the Sixth Pay Commission for central government employees has the potential to impact state government finances: state governments generally follow the central government pay hikes with increases of a similar magnitude.
CRISIL estimates that if state governments implement pay and pension increases similar to those following the Fifth Pay Commission, the aggregate primary deficit levels of 21 large states would rise to as much as 3.1 per cent of their aggregate gross state domestic product (GSDP) by 2011-12 (refers to financial year, April 1 to March 31). This level is higher than the 2.6 per cent recorded in 1999-2000, the first year in which the full impact of salary and pension hikes was felt in the wake of the Fifth Pay Commission.
This is also more than thrice the figure of 1 per cent targeted by the Twelfth Finance Commission (TFC). In such a scenario, the fiscal gains that the Finance Commission envisages by 2010 are not likely to materialise.
"In fact, since states routinely fail to meet finance commission targets, the actual deficits could eventually turn out to be larger than the estimates under the CRISIL study," says Roopa Kudva, executive director and chief rating officer, CRISIL.
CRISIL's study is based on the assumption that salary and pension growth caused by the Sixth Pay Commission will be similar to that caused by the previous pay commission, and that state governments will implement the recommendations with effect from April 2009. Consequently, in 2009-10, 2010-11 and 2011-12, salaries would grow by 15 per cent, 24 per cent, and 19 per cent, and pensions would grow by 18 per cent, 38 per cent, and 41 per cent, respectively. These increases mirror the year-on-year percentage increase experienced in 1997-98, 1998-99 and 1999-00, respectively, following the implementation of the Fifth Pay Commission's recommendations.
With these assumptions, CRISIL projects the aggregate increase in salary and pension expenditures for state governments, over the three years to 2011-12, at Rs.1.75 trillion. Consequently, the aggregate primary deficit of states in 2011-12 will triple from Rs.0.5 trillion (CRISIL's projection of TFC's 1 per cent target) to Rs.1.6 trillion. According to Sreenivasa Prasanna, head, rating criteria and product development, "These levels of deficit are very high, and may cause state governments' credit profiles to come under severe pressure."
There is also the question of whether the increased revenues resulting from buoyant economic conditions, and savings from ongoing workforce rationalisation programmes, will offset the impact of pay and pension revisions. CRISIL's views on this issue are not entirely sanguine. Some state governments have not been filling up non-critical vacancies arising from retirements, and are implementing outsourcing initiatives. However, these factors have had a limited impact on cumulative salary and pension expenses, and pensions continue to rise.
The buoyant economic conditions and consequent increases in state governments' revenues may be insufficient to counteract increases in salaries and pensions; historically, governments have tended to spend more when revenues increase. Moreover, TFC had already considered a large part of this buoyancy while setting the deficit targets for state governments. CRISIL believes that any ad-hoc implementation of pay commission recommendations, without